Many entrepreneurs are oblivious to the effect of the UK exchange rate on their business – a strange phenomenon considering the very real impact that it can have on performance. Most of us only really consider the value of the pound when we’re looking to go on holiday or travel abroad for business, but its effects are much more relevant than you might think.

The UK exchange rate has an important role to play in the profit margins of hundreds of thousands of domestic companies, from those who export goods overseas to those who import raw materials. When the pound does well, as it is now, exports become more expensive, imports become cheaper, and those firms who rely on foreign materials can see their production costs lessen and their profit margins increase. For exporting firms, however, these changes are less positive, reducing the competitiveness of UK companies.

But how, exactly, does it work?

The effect of depreciation in the exchange rate

If there is depreciation in the value of the pound, this has two primary effects on UK businesses: exports become cheaper, and imports become more expensive.

The best way to illustrate this is to look at some real examples. If we go back to January 2007, for example, the exchange rate was £1 to €1.50. Over the course of two years, this dropped, so that £1 became equivalent to €1.10.

This was good news for domestic exporters. Why? Well, lets imagine that a British car costs £5,000 to produce and £6,500 to buy. In 2007, this car would have cost European customers €9,750. By 2009, however, its value would have fallen to €7,150.

The profit margin of the exporting company would remain the same, yet overseas customers would have found prices much more competitive, making them far more likely to purchase the vehicle. Alternatively, the production company could keep the European price the same, and increase their profit margin at home. Either way, the outcome is positive: either more cars are sold, or greater profits are made on every sale.

The Effect of Appreciation in the Exchange Rate

At the moment, however, the pound is not depreciating, but appreciating. Although this is not great news for exporters, it’s very good news for businesses that import materials.

Why? Once again, the answer is simple. Depreciation means that the cost of raw materials is lower, and as a result companies that use imported goods in their products should benefit from a higher profit margin.

Lets imagine, for example, that our car company imports engines from Germany to make its vehicles, each of them priced at €1,500. In 2009, these would cost the production company £1,364 each. Today, however, the exchange rate is around €1.4, so this price would have dropped to £1,071, increasing company profit margins.

How will this exchange rate appreciation affect your business?

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